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Advisers who run well-managed firms offering a clear proposition and stable revenue streams will be in a strong position to sell come the RDR

It will not come as a shock when I say that financial advisory firms continue to face massive challenges ahead of the implementation of the proposals set out in the retail distribution review. But the need among UK consumers for expert, impartial financial advice is greater than ever.

There is little doubt now that the composition of the UK IFA sector is set to transform dramatically under the proposals set out in the retail distribution review.

Together with challenges presented by declines in the economic climate and significantly increased stock market volatility, many IFAs may find themselves finding it hard to compete. The FSA has, in the past, estimated that almost one in five advisory firms is loss-making and almost a quarter have reported profits of less than 5 per cent of turnover.

More recently, research by Momentum Global Investment Management stated that profit margins have declined considerably in the wealth management industry over the past two years and that the average profit margin in the IFA industry fell significantly, with over a third of IFAs making losses.

Ernst & Young recently predicted that the number of registered IFAs is likely to drop to 10,000 by 2013 – with the bulk of this reduction happening towards the end of 2012.

Whether they intend to sell their business and leave the industry or stay and thrive within it, advisers who develop well-managed businesses with a clear proposition and stable revenue streams are potentially building a highly valuable asset for themselves.

This may not be the best time to sell a business unless you have to, but it is certainly as good a time as any to start modifying a business to improve its value. After all, the attributes that make businesses more attractive to acquirers are also those that make it more able to withstand tough market conditions.

What do clients want?

The key findings from recent research found the following:

Post RDR advisory landscape

One in eight (13 per cent) individuals from mass-affluent to high net-worth households are specifically likely to seek out an ongoing fee-based service. However, a further 40 per cent were receptive to task-based advisory services. More than 80 per cent said they would seek professional advice to some degree with only 19 per cent wanting to be fully self-directed.

Key advice triggers

The need for expertise and lack of own knowledge was identified as the most common trigger for seeking out professional financial advice. Retirement concerns continued to dominate as the key area for seeking out advice, followed by investments and mortgages. Retirement planning was a concern for three quarters (75 per cent) of respondents and half of those said they would want a professional to research and/or set up an appropriate pension for them.

Winning attributes

A firm that can immediately grasp a prospect’s needs and demonstrate a clear track record of results for existing clients has the most appeal for prospective clients. Once using a service, clients will be most willing to pay a fee to an adviser that demonstrates proactivity in the shape of ongoing portfolio adjustments, regular reports and early warning of market volatility and financial events.

The research revealed that while the most sought-after client segment - those expressly seeking to pay for ongoing advice - is relatively small, there is a large proportion of mass affluent and high net-worth households seeking less conventional approaches to getting advice such as task-based and guided support. Firms that can think more creatively about how they can advise and service advice-seekers may make themselves far more acquirable than others.

Optimising the value of an advisory business

Certain internal factors can significantly enhance or reduce the valuation placed on small advisory firms by potential acquirers.

While there are clearly a number of quantitative metrics that can be used in the valuation for an unlisted IFA firm, the value of a small IFA, at any given time, will be governed by a combination of internal and external drivers. Internal drivers can be further broken down into quantitative and qualitative factors. Here, I intend to concentrate on the qualitative factors rather than the mathematics involved in calculating the cash value of a business:

Value enhancers for IFAs

There are many attributes that can enhance the value of an IFA business. Below I have assessed the core value enhancers that Ernst & Young suggests acquirers are actively seeking out.

■ Recurring and sustainable income

Fees agreed with the client as opposed to determined by product providers, are becoming especially valued in preparation for the implementation of the retail distribution review. As a very broad rule, acquirers favour firms where at least 30 per cent of revenue is recurring.

■ Clear advice proposition

A firm that clearly sets out its area of focus will attract a higher rating than a firm with an unclear, poorly executed, whole-of-market offering. A clear proposition can mean:

■ Client servicing that involves many touch points across a firm, not just one adviser.

■ High-quality adviser teams

Given the increased professional standards demanded by the RDR, acquirers will favour firms where RIs have, or are in the process of attaining level four qualifications.

■ Unique selling propositions and innovation

Finally, some firms will command a high valuation because they are doing something innovative and forward-thinking that holds a particular attraction for certain acquirers.

Value threats for IFAs

Of course, equally, there might be internal factors that can commonly lead to a downgrade in valuation by potential acquirers, some of which include:

■ Owner/key client relationship holder is seeking an immediate exit - before appropriate succession has been put in place and transfer of clients has occurred.

■ Over-reliance on few clients – that contribute too high a proportion of overall revenue.

■ Poor compliance and/or regulatory concerns - is likely to mean a number of buyers will not consider the acquisition at all.

■ Platforms and wraps: asset or liability? It is easier for an acquirer to manage the new assets if they are already registered on one venue. However, sellers need to be mindful that acquirers may have their own views on which platform technology is best.

A sector under change

Ernst & Young recently predicted that the number of registered IFAs is likely to drop to 10,000 (from a figure that has widely been reported as 20,000) by 2013. In the long term, this severe attrition may increase the value of those IFAs that remain. In the short-term, however, IFAs looking to sell or merge their business in the next year or so may find valuations under extreme pressure as a growing number of advisers rush for the exit. Even so, there is strong reason to believe that a small proportion of high quality IFAs can continue to stand apart and attract premium valuations.

Outlined in this article are the primary features that have enabled IFA firms to achieve a premium valuation – such as repeatable income, clear expertise and a loyal, well-serviced client base. But these are also the same qualities that will, I believe, enable IFAs to weather the current commercial, economic and regulatory headwinds (which is exactly why they are so prized by acquirers). The next few years are going to be extremely challenging for IFAs but by 2014, we envisage an advisory sector that is smaller, less fragmented but possibly more highly valued than ever before.